Armstrong Hardware lost most of its inventory in an electrical fire that destroyed the company's warehouse and retail store. Fortunately, the accounting records were backed up on the owner's computer in her home office and could therefore be recovered.
However, Armstrong uses a periodic inventory system, so without being able to perform a physical count, the company could not determine the amount of inventory lost in the fire. In order to process the insurance claim, the insurance company requires Armstrong to prepare a reasonable estimate of the lost inventory.
As Armstrong's accountant, you have been able to gather the following information:
1. Ending inventory, from the accounting records of last year, was $85,800.
2. In the current year, purchases up to the time of the fire totalled $486,500.
3. According to last year's financial statements, sales and the cost of goods sold were $964,000 and $578,400, respectively.
4. According to this year's accounting records, sales in the current year were $678,000.
Required:
a. Prepare an estimate of the amount of inventory lost in the fire. To ensure the reasonableness of the amount claimed, write a brief memo to the insurance company outlining your approach for determining the amount of inventory destroyed. You should also specify any assumptions used in preparing your estimate.
b. How would this process have differed if Armstrong had used a perpetual instead of a periodic inventory system?